The richest source of unwanted life insurance in a California estate planning practice is not a client who cannot afford premiums; it is an irrevocable life insurance trust holding a policy purchased to pay an estate tax the client will never owe. Those trusts were drafted under exemption levels that no longer apply. The grantor has stopped enjoying the annual gifting ritual, the trustee is watching the policy drift toward lapse, and nobody has asked whether the asset itself has a market value.
In California the transaction sits inside a defined statutory framework. Life settlements are governed by California Insurance Code sections 10113.1 through 10113.3, regulated by the California Department of Insurance, and the statute includes a notice-of-alternatives-to-lapse requirement precisely because owners were allowing valuable contracts to terminate without knowing options existed. Separately, California’s Medi-Cal program eliminated the asset test for non-MAGI long-term care eligibility effective January 1, 2024 (as of 2026, confirm current figures and that the repeal remains in force), which changes how a liquidity event interacts with your clients’ long-term care planning here versus in other states.
What follows is written attorney to attorney: how to spot the over-insured trust, the tax mechanics you need to be conversant in before the client asks, the trustee duty question, and exactly how a referral works. This is education, not legal, tax, or investment advice, and nothing here is an offer to purchase any policy.
In This Article
- Start Here: Send a Redacted Cover Page
- The Over-Insured ILIT Problem
- The Trustee’s Duty Before the Client’s Preference
- Tax Mechanics You Should Be Conversant In
- How California’s Statute Frames the Transaction
- The Long-Term Care Overlay in California
- How a Referral Works
- Language for the File
- Frequently Asked Questions
Start Here: Send a Redacted Cover Page
If a trust-owned policy is already on your mind, the fastest path is to send the policy cover page, with the owner’s permission, and get a read on whether it is a market candidate. Redact whatever you like. Turnaround is typically one to two business days, the review is free, and there is no obligation on you, on the trustee, or on the grantor.
Free policy review: (305) 209-7183. Pine Lake Life Solutions works with policies of $100,000 or more in death benefit and typically pays more than cash surrender value. This page is educational only.
The Over-Insured ILIT Problem
A generation of ILITs was funded to solve a liquidity problem at death: the estate would owe federal estate tax, the assets were illiquid, and a second-to-die policy was the cheapest way to write the check. Federal exemption levels have moved substantially since those trusts were drafted, and the great majority of clients who bought that insurance are no longer in taxable estates at all. Verify the exact 2026 federal exemption amount and any California-level considerations before you put a number in a client letter.
What is left is a trust whose stated purpose has evaporated but whose premium obligation has not. Sometimes the right answer is to keep the coverage for a non-tax reason: equalizing between a child in the family business and one who is not, funding a buy-sell, or protecting a special needs beneficiary. Sometimes the right answer is that the policy is a legacy expense the family is funding out of habit.
Grantor fatigue is the reliable early signal. When Crummey notices start going out late, when the grantor asks whether the gifts are really necessary, or when the trustee reports that the last premium came in after a reminder call, the trust is heading toward a decision. Making that decision deliberately is better than making it by lapse.
The Trustee’s Duty Before the Client’s Preference
Under prudent-investor principles, a life insurance policy held in trust is an asset the trustee must monitor, not a set-and-forget item. That means periodically obtaining an in-force illustration, checking whether the policy will actually carry to maturity at current crediting rates, and documenting the review. When the analysis shows the policy no longer serves the trust purpose, the trustee’s realistic option set is: keep funding it, reduce the face amount, convert to reduced paid-up, surrender for cash value, or test the secondary market.
Only the last option lets a third party set the price. Surrendering without testing the market means the trustee accepted the carrier’s number without knowing what anyone else would pay, and that is the criticism most likely to appear in a beneficiary complaint later. As drafting and advising counsel, your job is usually to make sure the trustee documents that the comparison happened, whatever the outcome.
Where beneficiaries have divergent interests, get their positions in writing. A settlement converts a future death benefit into present cash, which is a real change in who gets what and when.
Tax Mechanics You Should Be Conversant In
You will not be signing the return, but you will be the first person asked. The general framework after the 2017 tax act and Revenue Ruling 2020-05 is that seller basis is generally total premiums paid, without the old reduction for cost-of-insurance charges. Proceeds up to basis are a return of capital, gain up to the policy’s cash surrender value is ordinary income, and gain above cash surrender value is generally capital gain.
A sale to an unrelated buyer is typically a reportable policy sale under IRC section 6050Y, which generates information reporting on Forms 1099-LS and 1099-SB. The seller will receive paper and will call someone about it. Tell them in advance that it is coming and route the analysis to their CPA.
Transfer-for-value is the trap worth naming in any internal restructuring. Moving a policy between trusts, to an entity, or to a beneficiary can, in the wrong fact pattern, taint the income-tax-free character of the death benefit under IRC section 101(a)(2). Check the exceptions before you move ownership as a step in a settlement or a wind-down.
| Option for a Trust-Owned Policy | What the Trust Receives | Documentation the Trustee Should Keep |
|---|---|---|
| Keep paying premiums | Full death benefit at maturity | Current in-force illustration showing the policy carries |
| Reduce face amount | Smaller benefit, lower premium | Carrier reprojection and beneficiary notice |
| Convert to reduced paid-up | Paid-up benefit, no further premium | Carrier confirmation of the reduced benefit |
| Surrender to the carrier | Cash surrender value stated by the carrier | Latest statement showing the surrender figure |
| Test the secondary market | Market-set price, if any; typically quoted as a range of face value | Written indication plus the surrender figure for comparison |
| Do nothing | Lapse, and generally nothing | Not a defensible outcome once the trustee is on notice |
How California’s Statute Frames the Transaction
California Insurance Code sections 10113.1 through 10113.3 supply the state’s life settlement rules, administered by the California Department of Insurance. The framework contemplates licensed providers and brokers, mandated pre-contract disclosures, a rescission right after a contract is executed, and privacy limits around the medical information collected during underwriting. California also requires carriers to give lapse notice and to permit an owner to designate a third party to receive it, which is the mechanism that most often buys a family enough time to evaluate options.
Confirm the current statutory text and any 2026 amendments directly with the Department of Insurance. Ask any company involved in a client transaction, in writing, where it is licensed as a provider or broker. Pine Lake Life Solutions offers education and a free policy review; nothing here should be read as a claim about licensure in California.
The Long-Term Care Overlay in California
Estate planning clients age into care planning, and California’s rules are unusual. Medi-Cal eliminated the asset limit for non-MAGI long-term care eligibility effective January 1, 2024; as of 2026, verify with the Department of Health Care Services that the repeal remains in force. Estate recovery in California has been limited to assets passing through the probate estate since 2017, which raises the planning value of non-probate transfers.
Practically, that means a California client is less likely to need a settlement to qualify for benefits and more likely to need one to pay for care that benefits do not cover: private caregivers, assisted living, home modifications, or simply the gap before a placement. Note also that California has a filial responsibility statute on the books; verify its current enforcement posture in 2026 before an adult child asks whether they can be pursued for a parent’s care bill.
How a Referral Works
The professional’s step is small: with the owner’s permission, send the policy cover page. Nothing else. That produces a free, no-obligation read within roughly one to two business days on whether the policy looks marketable.
If it does, the file for an indicative range is four documents: the cover page, a current in-force illustration, the most recent carrier statement, and a HIPAA authorization signed by the insured. The trustee or owner signs; you do not. From submission to funding, a standard file runs roughly 60 to 120 days, with carrier and medical-records turnaround driving the timeline.
On value, use ranges only. Gross offers in this market commonly land between roughly 10 and 35 percent of face value depending on age, health, policy type, and premium load, and GAO-10-775 found settlements produced meaningfully more than surrender value, on the order of four to eight times, for the policies studied. No one can price a policy from a cover page; the cover page only answers whether it is worth building the file.
There is no compensation to the referring attorney, and the client or trustee retains the right to decline any offer at any stage.
Language for the File
Two short additions make this durable. In the trustee’s annual review memo, add a line recording that the policy’s cash surrender value and, where appropriate, a market indication were both considered. In the client’s engagement or closing letter, add a line stating that you described the available alternatives, that you are not rendering tax or investment advice on the disposition, and that the client was directed to independent tax counsel.
That is the whole compliance footprint. The substantive work is the same policy-review discipline you already apply to every other asset in the plan.
Frequently Asked Questions
Why are over-insured ILITs the best place to look?
Because the reason the policy was bought no longer exists for most families. The trust was funded to pay a federal estate tax the client is unlikely to owe at current exemption levels, so the premium is now buying a benefit nobody planned around. Verify the exact 2026 exemption before quoting numbers to a client.
Can a trustee sell a policy without beneficiary consent?
It depends on the trust instrument and applicable trust law. The trustee’s powers clause, the trust’s stated purpose, and the duty of impartiality among beneficiaries all bear on it. Many trustees obtain written beneficiary consent or a nonjudicial settlement agreement even when the instrument arguably permits unilateral action.
What is the seller’s basis in the policy?
Under Revenue Ruling 2020-05, conforming to the 2017 tax act, basis is generally the total premiums paid without a reduction for cost-of-insurance charges. That is more favorable than the older Revenue Ruling 2009-13 treatment. The actual computation is fact-specific and belongs to the client’s CPA.
What is 6050Y and will my client get forms?
IRC section 6050Y imposes information reporting on reportable policy sales, running to the buyer, the issuer, and the seller, and it generates Forms 1099-LS and 1099-SB. Yes, the client will receive forms. Warn them in advance so the paperwork is expected rather than alarming.
Does a settlement affect the transfer-for-value rule?
The transfer-for-value concern applies to transfers of an existing policy that can convert an otherwise tax-free death benefit into taxable income for the recipient. It matters most when you are restructuring ownership internally. Check IRC section 101(a)(2) and its exceptions before moving a policy between trusts or to a beneficiary.
What kinds of policies actually have a market?
Typically universal life, guaranteed universal life, whole life, and convertible term with at least $100,000 in death benefit, where the insured is roughly 70 or older or has experienced a material health change. Non-convertible term generally has no market once the conversion window closes.
How long does the transaction take?
Roughly 60 to 120 days for a standard file from submission to funding. Most of the elapsed time is carrier document turnaround and medical records retrieval. The initial free read on a cover page comes back in about one to two business days.
Is there any cost or obligation to the attorney or the client?
No. The policy review is free, there is no fee to the referring professional, and no compensation flows to you. The owner keeps control and can decline any offer at any point without cost or penalty.
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Related Reading
- Life Settlement Vs Surrender
- Cash Surrender Value Life Insurance
- Life Settlement Taxes California
- Life Settlement Licensing California
- How It Works Policy Options
- Education Center
Pine Lake Life Solutions does not purchase life insurance policies and does not provide legal, tax, or investment advice. Information provided is for educational purposes only. Eligibility for any option, including life settlements, is not guaranteed and depends on individual circumstances, policy terms, underwriting, and market conditions. Consult independent legal, tax, or financial professionals before making decisions regarding a life insurance policy.